Tuesday, September 22, 2015

Financial independence via self-employemnt is still possible, and there are a number of pathways to that goal.

The conventional financial industry touts gaining financial independence by playing Wall Street's game: working a conventional job for decades to accumulate a chunk of money in retirement funds that Wall Street wizards magically squeeze for hefty annual returns in a zero-yield world--in a completely risk-free manner that keeps your nest egg intact, of course.

This annual yield on the large sum squirreled away over the decades then (supposedly) enables a spacious retirement home on the golf course, luxury cruises, etc. (Uh, right. Unless stocks and bonds crater, Wall Street's hedges crumble and the global economy slides into recession--y'know, everything that's happening now.)

(And never mind many households can't possibly save enough to accumulate a big nest egg due to stagnating wages and soaring costs of big-ticket expenses like healthcare and college.)

The other pathway to high-income retirement is to manage your career to earn multiple government pensions: in areas with large Department of Defense (DoD) installations, (military and civilian), this often means 20 years in military or civil-service that comes with a pension and healthcare benefits, followed by a second career in another government agency that secures another pension and maybe Social Security, too: this is the classic Triple-Dipper retirement plan.

A similar pathway is to have two workers in the household each retire with a government pension and Social Security, so the household income includes four secure pensions.

The third avenue to financial independence is not so much about retirement--it's about financial independence during your career/working life as well as retirement. The ideal retirement scenario for the self-employed is simply a reduction in the work you don't much like and a continuation of the work you enjoy until the end of your life.

My credo is: Focus not on retiring comfortably, but on working comfortably.

Self-employment is a core mythology of the American Dream--working for yourself as the ideal form of work. Self-employment's place in the pantheon of American ideals did not prepare me for startling reality that a mere 5% of the workforce (about 7.4 million out of 145 million) earn a middle class living as self-employed (i.e. sole proprietors or partnerships/S-corporations with no employees).

I laid out the statistics in Endangered Species: The Self-Employed Middle Class. According to the source, there are roughly 6 million small businesses with employees. While running a small business with employees is certainly working for yourself, the requirements in terms of management, experience and capital are far more daunting than sole proprietorship, which is why I'm focusing only on the 7.4 million sole proprietors who make $50,000 or more annually.

This picture isn't entirely complete, however; unearned income, for example, from rental properties or family trusts, is not recorded as self-employed income (Schedule C); rental income is reported on Schedule E, and these earnings are not subject to self-employment payroll taxes (15.3%, as the self-employed pay both the employee and the employer portions of the payroll taxes).

So someone who owns rental properties could be financially independent and not be officially considered self-employed, even though they actively manage their properties.

There are a number of other interesting statistics in the IRS spreadsheet Table 1.4, All Returns: Adjusted Gross Income, Exemptions, Deductions, and Tax Items for tax year 2012 that help us understand how the self-employed earn their income.

This data tells us how many people are earning middle-class incomes from rental properties, royalties and earned income.

The IRS reports that 18.7 million taxpayers paid self-employment taxes, and 7.4 million of them earned $50,000 or more annually.

8,214 of these self-employed raked in $10 million or more annually. (I presume this includes athletes, film stars, etc.)

4.8 million people reported positive rental income, of which 2.95 million reported earning $50,000 or more in rental income annually.

1.25 million taxpayers reported earning $50,000 or more in royalties annually. (7,585 reported earning $10 million or more in royalties--subtracting Steven King and a few musicians, who else earns these princely sums? I suspect most are patent royalties.)

As I noted before, only 2.4 million earners deducted healthcare insurance payments. This suggests that many of the self-employed are in households where someone is getting healthcare coverage for the household from their employer. Alternatively, millions of self-employed don't have any healthcare insurance. This seems unlikely.

For this reason, I consider this the most accurate guide to the truly self-employed earning a middle-class income: 2.4 million people out of a work force of 145 million.

So what does all this say about self-employment? I think we can draw a few conclusions:

1. Establishing a profession is one tried-and-true way to be self-employed. Obtaining the diploma and license does not guarantee an income, of course, as competition can be plentiful in certain professions and regions.

2. Owning rental properties is a path to financial independence that works for almost 3 million people/households.

3. Owning the rights to creative content or patents that generate royalties is a ticket to financial independence for 1.25 million people.

4. There are many other sole proprietorships (about 3 million based on the IRS data) that manage to net $50,000 or more annually. Presumably some qualify as Mobile Creatives who cobble together several income streams to generate enough to live independently.

5. Over 10 million people are earning meaningful sums from small (less than $50K/yr) enterprises, rentals and royalties. These don't generate $50,000 a year, but they still make an important contribution to financial independence, income and capital/wealth.

6. Businesses that eventually earn $50,000 or more typically start small, so many of the people currently earning less than $10K/year could over time increase their income or add another modest income stream.

Financial independence via self-employemnt is still possible, and there are a number of pathways to that goal. The path I consider the most flexible and thus the most attainable by non-professionals is the Mobile Creative idea of generating multiple income streams, preferably from sources that are not all tied to the same industry so that a downturn in one sector won't wipe out the entire household income.

The Mobile Creative credo is simple: trust your network, not the corporation or the state.

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